Let’s take a look at each of the variables and see what it can indicate in a company.

But first, before we dive in, if you haven’t done so, click this image and enter your email. You’ll get a link to download an Altman Z score spreadsheet which will help you understand this topic better.

Altman X1 = Working Capital / Total Assets

This ratio provides information about the short term financial position of the business based on the balance sheet.

The more working capital there is compared to the total assets, the better the liquidity situation.

With working capital you still have to remember two points.

Point #1: Negative working capital isn’t always bad

Companies with high inventory turnover can have negative working capital. If you take a look at Wal-Mart (WMT), it has leverage over their suppliers with favorable payment terms so their current liabilities can outweigh their current assets.

Other examples include telecom companies such as Verizon (VZ) and airlines like Southwest (LUV) and Allegiant (ALGT).

Point #2: High positive working capital isn’t always good

Just because working capital is high, it doesn’t automatically mean that it is good.

It can indicate the company has too much inventory or they are not investing their excess cash.

Altman X2 = Retained Earnings / Total Assets

Retained earnings is the percentage of net earnings that isn’t paid out as dividends – hence the word “retained”.

The company will use it to operate the business. It can be reinvested or used to pay off debt. Up to management.

But when you combine it total assets, the purpose of the ratio is now to measure how much the company relies on debt.

Makes sense.

If a company has little to no retained earnings, then it has to get money from somewhere to continue with operations. Where does that money come from? Debt or dilution.

The lower the ratio, the company is funding assets by borrowing instead of through retained earnings.

This ratio is also a cousin to the equity multiplier used in the DuPont Analysis where Equity Multiplier = Total Assets/Shareholders Equity

Altman X3 = EBIT / Total Assets

If you squint hard enough at EBIT/Total Assets, it will look familiar.

It’s a variation of a common ratio that you see everywhere.

Don’t see it? Neither did I.

EBIT/Total Assets is a variation of ROA.

Instead of net income, EBIT is used in the numerator.

ROA = Net Income/Total Assets

The definition is the same though.

This ratio looks at the company’s ability to generate profits from its assets before deducting interest and taxes.

Altman X4 = Market Value of Equity / Total Liabilities

Out of the 5 components, this is the most controversial.

This ratio is supposed to show you how much of the company’s market value could decline before liabilities exceed assets.

The problem is that if the stock price is high, then this ratio goes up.

Here are two examples

Tesla (TSLA)

Market Cap: 51.18B

Total liabilities: 17.54B

Market Value of Equity / Total Liabilities = 51.18/17.54 = 2.9

Wix.co (WIX)

Market Cap: 3.69B

Total liabilities: 217.15M

Market Value of Equity / Total Liabilities = 3.69/0.217 = 17

Both companies have negative PE’s, but because of Wix.com’s stock price compared to Tesla, it has a higher ratio.

Of the 5 Altman Z score components, #4 is the least important and the one I use the least.

Altman X5 = Net Sales / Total Assets

This ratio is just asset turnover.

I use it all the time outside of the Altman Z score as well as it is a great indicator of efficiency and business quality when comparing against previous years.

Quite simply, it is looking at the dollar of sales generated by the company for every dollar of assets.

The more money you can generate from assets, the better.

If two people start with $1,000 in total assets, but person A generates $1,000 while person B generates $2,000, the winner is a no-brainer.

Screen for Stocks using the Altman Z Score and Components

One of the things we do at old school value is to provide off-the-wall type value metrics. Instead of sticking with the same ratios and numbers every other screener has, we include Altman Z scores as well as each component.

Go to OSV Online, click on screener and then type in “Altman” or click the Altman category to expand the possible data selections.

Create Your Own Altman Z Screener

Even if you don’t have access, you can play with it in the live preview mode. Click to view, then go to screener.

Free Altman Z Screener

To get a list of stock ideas where the Altman Z Score is higher than 3, you can use the free Altman Z Screener.

The free screens are updated weekly with fresh stock ideas.

Free Altman Z Spreadsheet

As the last cherry on top, download the free Altman Z spreadsheet I have prepared for you.

Put it into practice with the free Altman Z score spreadsheet. Click on the image and get it via email.

Keep in mind that the actual Altman Z score is not a clear bankruptcy indicator.

In fact, there is no such thing. There are other models to try and predict bankruptcy, but nothing is accurate.

We are driven to provide useful value investing information, advice, analysis, insights, resources, and education to busy value investors that make it faster and easier to pick money-making value stocks and manage their portfolio.

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